Will Biden’s Student Loan Relief Plan Boost Inflation?

Today, President Joe Biden announced forgiveness of up to $20,000 of debt for lower income Pell grant recipients and $10,000 debt for other student loans. This is available for those earning under $125,000 (or $250,000 if married filing jointly). However, after a long pause, student loan repayments will resume in January 2023.

The Inflation Impact

What will this mean for U.S. inflation which is currently running at 8.5% year-on-year? Though inflation moderated month-on-month for July will this student loan initiative push inflation higher?

The Economic Perspective

Economist Lawrence Summers of Harvard is on record as stating that student loan relief will raise inflation, as he tweeted earlier in the week. “Student loan debt relief is spending that raises demand and increases inflation.” That’s logical, but the question remains how much of an impact will this initiative have?

Student Loan Relief vs. Stimulus Checks

From April 2020 to March 2021 the government issued three tranches stimulus checks (Economic Impact Payments) of over $3,000 in total to those with similar income levels. So at first glance, the student loan forgiveness may have a greater impact.

However, the impact of wiping out debt isn’t quite so sudden. The beneficiaries of relief will not receive the $10,000 benefit in one go like they would with a stimulus check. For example, Nerdwallet pegs the average student loan interest rate at around 5%. Yes, you are $10,000 richer if your student debt goes away by that amount, but it’s hard to go out and spend that money all once, because no one is giving you the cash, just wiping away a series of payments you probably have to make over a longer period of time.

The Calculations

With a 5% interest rate, and $10,000 of debt relief your payments for both interest and repayment of principal may fall by around $800-$1,500 a year depending on the terms of your loan. That’s not too different to the size of stimulus checks during the pandemic. However, in some circumstances student loans would ultimately be cancelled anyway under existing rules, in this case the forgiveness is not quite as large as it appears.

Taxation

Also, in some cases state taxes (but not federal taxes) may be owed on the debt forgiveness which would reduce the benefit.

Will It Be Inflationary?

Interestingly, today’s announcement may not be too inflationary for the U.S. economy for one simple reason. It’s the long-lived repayment pause, that’s set to end. Consumers have had a pause on their student loan repayments and interest for years because of the pandemic.

Repayment Restart

In January 2023, those repayments are planned restart. Yes, they’ll be at a lower level for many because of the relief for lower-income earners, but they will restart nonetheless, and that’s probably the bigger factor for consumers after years of not having to make those payments.

That resumption of loan payments will likely reduce discretionary expenditure and may actually be slightly deflationary in the short-term. Of course, some economic theories suggest that consumers may have carefully budgeted for student loan payments throughout the pandemic, and, so the impact on expenditure will be less as people took a long-term approach to managing their student debt. If that’s the case then perhaps January will see a boost to inflation. However, it’s more likely that student loan repayments resuming could slightly weaken the consumer in 2023 as they have to divert cash that would have gone on other goods and services to repay student loans.